Posted: Mar. 09th 2020
OPEC + Alliance Breaks
OPEC held an extraordinary meeting in Vienna at the close of last week to review market developments and its outlook for the remainder of 2020. The 178th meeting of OPEC was more important than most due to the scheduled expiration of OPEC+ production cuts at the close of March, and the spread of the COVID-19. The results of the meeting were truly extraordinary, resulting in the fracturing of the long-standing Saudi Arabia – Russia alliance.
Preceding the recent OPEC meeting, Saudi Arabia had been signaling that it wanted OPEC+ countries to agree to deeper cuts to address the unexpected hit to demand caused by the COVID-19 virus. The Saudi proposal was in addition to the recent expansion agreed by the OPEC+ group in December 2019. It was clear from the outset that Russia was not enamored with the idea. In the days leading into the OPEC meeting, Russia had declined to publicly support Saudi Arabia’s proposal or provide any constructive commentary.
At the OPEC meeting on Thursday, as expected, OPEC members followed Saudi Arabia’s lead agreeing in principle that the group would cut an additional 1.5 mb/d over and above the current commitment of 1.7 mb/d approved in December. The further cuts were to be apportioned 1.0 mb/d pro-rata amongst OPEC members and 0.5 mb/d with the non-OPEC members of the participating group. The expanded production cuts were to remain in place until 30 June 2020. The agreement was conditioned upon Russia, the largest non-OPEC participating member, accepting the additional cuts.
On Friday, discussions between OPEC (led by Saudi Arabia) and Russia ended with no agreement. Worse yet, Russia walked away from the meeting and stated that it expected the current production cut agreement to expire at the end of the month freeing all members to produce without restrictions. After three years of last-minute breakthroughs, the market was caught wrong-footed by the news and dropped more than 9 percent on Friday.
The OPEC+ alliance lasted in excess of three years. Through this period, we were always dubious as to its efficacy and durability. Prices languished despite the increasing level of production cuts, and, in reality, Russia never lived up to its commitments. In short, Russia received the benefits of participating in the OPEC+ agreement, what little there was – at best price stability, and Saudi Arabia did most of the heavy lifting in relation to cuts. We assumed Saudi Arabia was willing to live with the arrangement in order to float the stock of Saudi Aramco. It was clear from the start; there was never a real partnership and that when the parties’ interests diverged wide enough, the marriage would not survive.
The break finally happened last Friday. By walking away from the meeting with no agreement whatsoever, not even an extension of the current production cuts, Russia effectively detonated its relationship with Saudi Arabia. It did not take long for Saudi Arabia to respond. Over the weekend, Saudi Arabia dramatically slashed its official selling prices (OSPs) for April exports, including the biggest cut ever for Arab Light crude for Asia. In short, the breaking of the alliance looks to have set off a price war between two of the world’s largest suppliers just as global demand is weakening.
As set forth in our International Crude Oil Market Analysis & Forecast, NUS expected crude oil prices to decline materially in 2020 due to weak economic growth and underlying demand. However, the implosion of the OPEC+ alliance and the spread of the COVID-19 virus exacerbates what we anticipated as a difficult year for the global crude oil markets. There can be little doubt that the crude oil markets can expect more turbulence and volatility in the coming weeks and months. Many are predicting a replay of the 2014 declines – it is a bit premature to make such predictions. However, a few things are clear.
• Due to declining global demand, this is the absolute worst time for a price war between Saudi Arabia and Russia.
• The collateral damage from the developing price war is going to be the United States shale industry.
• Russia appears to have been preparing for this possibility for some time. So, it may be prepared to withstand lower prices for an extended period of time to inflict maximum pain on both Saudi Arabia and the United States.
• There is a lot more downside and precious little news on the horizon to support crude prices.
Based on the preceding, it is entirely possible prices fall below the worst levels seen in 2014.
Buckle up – the next few weeks are going to be extremely interesting.